Everything can change
While this comment was being written right after the close of the sugar trading session in NY on Friday, there were strong rumors that Putin’s Russia’s invasion of Ukraine was just a matter of days and can take place before the end of the Winter Games, which are being held in China and end on February 20. So, everything can change on this market.
If there is an actual invasion, the developments of such military action will bring huge volatility to the markets, especially to the energy market which this year is already leading the highest positive variation of 2022: heating oil, oil, and RBOB show an appreciation of more than 22% in the yearly accumulated.
Another component to be analyzed by the mills in the basket of variables can deeply affect the supply and demand equation and sugar/ethanol pricing now at the start of the sugarcane crop in the Center-South which starts to be crushed soon.
The sugar futures contract closed out the week with March/2022 at 18.29 cents per pound, a slight increase of just 6 points compared to the contracts from March/2023 on, where the appreciation was above 30 points (almost seven dollars per ton on average). On the other hand, the real appreciation against the dollar has affected the average sugar price in real in the week causing a retraction of a little over R$30 per ton. In short, NY hasn’t gone up enough to halt the loss caused by a weaker dollar against the Brazilian currency.
With both eyes open on the 2022/2023 crop of the Center-South, the futures contracts related to it (from May/2022 to March/2023) start to outline a curve of carry. I will explain – just three months ago the N/V 2022 and V22/H23 spread were inverted, making the market anticipate/believe in a shortage of the product, on top of the domestic interest rate effect, which pressures the futures curve in real per ton and helps the spread open even more. Today, both spreads are in carry, that is, July/2022 is quoted at a smaller price than October/2022 and the latter is smaller than March/2023, despite the futures curve having a component of even higher domestic interest rates. What has changed?
First, the market seems to be more comfortable with the size of the next sugarcane crop in the Center-South, considering it to be enough to meet the sugar and ethanol demands. However, the physical market is still lethargic causing a fall in sugar prices for the domestic market and the shrinking of hydrous ethanol demand. The trend for this coming crop is that the arbitrage between sugar and ethanol will be pretty narrow.
However, I understand that hydrous ethanol is the product with the greatest potential to present better profitability this crop for three major reasons: first, the already mentioned tension between Russia and Ukraine; second, there is a 17% gap between the gas price on the foreign market and the price practiced by Petrobras in the refinery. How long the company will hold back this appreciation is unknown, but should a conflict break out, price damming will become unfeasible; third, other sugar producing countries will supply the foreign market limiting price rises. The best price perspectives won’t come from sugar, but from the oil market or some exogenous factor that is under the radar right now.
Right now, the high interest rates practiced by the Brazilian Central Bank (10.75% per year with a 12.25% high bias) attracts the entry of investors to the country and pushes the currency quote down. The ethanol arbitrage with sugar stays neutralized as long as this last. The thing is we are in an election year and federal government expenses led by a president seeking reelection at any cost can aggravate the fiscal, political and economic crises bursting the comfort zone the real is in today. That’s why I see ethanol as having the greatest high potential.
The funds keep on liquidating their longs and according to the last report released by the CFTC (Commodity Futures Trading Company), they have reduced the position to 45,000 lots.
But I believe that the situation for the 2023/2024 crop (April/2023-March/2024) is pretty different. Sugarcane availability in the Center-South isn’t going through an increase in area, quite the opposite. It’s common to hear mills comment about the reduction in sugarcane growing area on the part of their suppliers and/or change to more profitable crops (grains). Some mills mention a retraction of up to 4%. The supply can be tight if we have any weather problem combined with the global economy recovery and the domestic growth recovery.
A new increase in the interest rates in Brazil in March means the futures curve of the real will make for a better sugar pricing for export in the 2023/2024 crop which can raise the average values of NY to the equivalent of R$2,400 per FOB ton. A recommendation that must be studied with the greatest discipline is the price fixing of sugar in real per ton for that period, combined with the simultaneous purchase of out-of-the-money calls 200 above the market. Therefore, the mills now have a synthetic put in real per ton, participating in possible price rises in cents per pound. But let’s keep an eye out for what might happen between Russians and Ukrainians.
To read the previous episodes of World Sugar Market – Weekly Comment, click here
To get in touch with Mr. Arnaldo, write on arnaldo@archerconsulting.com.br
